The promissory note stated a monthly rate and never stated its yearly equivalent. Recoverable interest fell to five per cent, and the interest already paid came off the principal.
At a glance
A printing and signage business in Kitchener sold for $1.45 million on a share purchase. The buyer funded $1 million from a bank and the vendor took back a $450,000 note, interest only for the first three years. The purchase agreement was drafted and negotiated by two firms over six weeks. The note itself was a two-page template the parties had found and completed between themselves, attached as a schedule, and it said what both of them had agreed in the room: interest at 1.5% per month, calculated and payable monthly on the first of each month.
One and a half per cent a month is eighteen per cent a year on a nominal basis, and 19.56% if it compounds monthly. Neither figure appears in the note. Federal law has required for more than a century that a contract stating interest for a period shorter than a year also state the yearly rate to which that period rate is equivalent, and the sanction for omitting it is not a penalty or a disclosure order. It is a cap of five per cent, and it reaches backwards.
The buyer's new accountant spotted it in month twenty-six, during a refinancing. The vendor's position — that both parties were commercial, both understood the rate, and the buyer had paid it without complaint for over two years — is all true and all irrelevant to the provision.
Interest at 1.5% per month on $450,000 is $6,750 a month. Over twenty-six months the buyer paid $175,500. Interest recoverable at the statutory five per cent per annum over the same twenty-six months is $450,000 × 5% × 26/12 = $48,750. The excess is $126,750.
Because the statute allows that excess to be deducted from principal, the note's balance fell from $450,000 to $323,250 — a reduction of 28.2% achieved by the absence of a single sentence. On the refinancing the buyer paid out $323,250 and the vendor's counsel advised him not to litigate it.
Section 4 of the Interest Act, marginal note When per annum rate not stipulated: “Except as to mortgages on real property or hypothecs on immovables, whenever any interest is, by the terms of any written or printed contract… made payable at a rate or percentage per day, week, month, or at any rate or percentage for any period less than a year, no interest exceeding the rate or percentage of five per cent per annum shall be chargeable, payable or recoverable on any part of the principal money unless the contract contains an express statement of the yearly rate or percentage of interest to which the other rate or percentage is equivalent.”
Three things about that sentence decide the file. First, the carve-out is defined by what the security charges, not by who the parties are: the exception covers mortgages on real property and hypothecs on immovables, so a note secured on business assets is squarely inside the section however sophisticated the parties. Second, the consequence attaches to the whole of the interest, not to the excess over five per cent — no interest above five per cent is chargeable, payable or recoverable on any part of the principal money. Third, the cure is a statement, not a rate: the section is satisfied by disclosing the yearly equivalent, at any rate the parties like.
Section 5 is what makes it bite backwards: “If any sum is paid on account of any interest not chargeable, payable or recoverable under section 4, the sum may be recovered back or deducted from any principal or interest payable under the contract.” The buyer did not need to sue for the $126,750. He deducted it.
Section 4 is not a usury provision, and confusing it with one is how commercial parties talk themselves out of it. Section 3 handles the different case where a contract provides for interest and fixes no rate at all: “Whenever any interest is payable by the agreement of parties or by law, and no rate is fixed by the agreement or by law, the rate of interest shall be five per cent per annum.” Section 4 is about disclosure of an equivalence, and it bites at any rate however modest — one per cent a month, stated without its yearly equivalent, is caught on exactly the same terms as five.
The vendor took $323,250 on the refinancing and the relationship ended badly over a drafting omission neither party had intended. The buyer's counsel now reviews every promissory note attached to an agreement it drafts, on the footing that the schedule the clients wrote themselves is where the money is. See setting the interest rate and term on a seller note.
The cure is one sentence, and the safe form of it states both equivalents, because whether the yearly rate to which a monthly rate is equivalent means the nominal 18% or the effective 19.56% has been argued more than once: Interest is payable at 1.5% per month, which is equivalent to 18% per annum calculated monthly not in advance, and to 19.56% per annum calculated annually. That is drafting practice rather than a rule, and it is offered as such; the section itself requires only an express statement of the yearly equivalent.
The sentence costs nothing. The omission cost the vendor $126,750 of principal plus the $126,750 of interest he never received on it going forward. Against a $1.45 million transaction on which both sides paid full legal fees, the single unreviewed document was the one carrying deferred consideration — which is the pattern worth remembering. Purchase agreements get reviewed because they look important. Notes get attached.
The tell is any rate expressed per month, per week or per day. Read every deferred consideration instrument for a period shorter than a year, then look for the words per annum in the same clause. If the second is missing, the recoverable rate is five per cent whatever the first says, and every payment already made is a credit against principal.
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